Investors should be wary of crowded credit trades that are too limited in their focus, Hermes Investment Management has warned.
Hermes credit co-head and senior portfolio manager Fraser Lundie said it is important to have a broad and flexible mandate to capture the growing set of opportunities outside the UK and to avoid losses.
He said that where money has flowed out from other managers recently, it has been well-managed because those credit strategies have been very broad. The major problem is where funds have become too big with too narrow a mandate, such as the short duration high yield universe, he said.
"If you're going to be wrong, I would think it pays more than ever to be wrong in a place where no one else is than if you're going to be wrong in a place where everyone is, given this liquidity backdrop that will be quite punishing."
Liquidity has fallen to a near-record low, almost at levels seen in 2003, amid booming issuance, he said. Having a home bias, such as focusing too much on European credit rather than emerging market credit, will have implications for liquidity, he added. In a falling market this could lead to investors suffering heavy losses when unwinding positions.
To mitigate the problem, people need to be more formulaic and sensible about capacity constraints, which has not happened quickly enough yet, he said.
The firm sees opportunities in high quality US high yield in areas of the market that have been sold off too aggressively such as specialty chemicals and gold.
Lundie also believes investors should get paid more from European credit. He urged a great deal of caution when going down the credit quality chain given that recent defaults have had low recovery rates.
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